How You Can Beat Fund Managers?
There is no better book for beginners in the stock market than One Up On Wall Street by Peter Lynch. The cover says, “How to use what you already know to make money in the market”, and the book very well lives up to it.
Before starting the book review, first let us learn about Peter Lynch. He was a fund manager at Fidelity for 13 years from 1977. During his tenure, he returned over 29%, beating the S&P 500 by more than twice.
An investor who put $1,000 into the fund the day Lynch took over would have had $28,000 the day he left.
We’ll be talking about the top takeaways from the book One Up On Wall Street.
Pay Attention To The Products That Regularly Come In Your Contact
This is one of the most important lessons of the book. Lynch stresses on the importance of looking at the companies whose products you use or come across in your day to day life.
“If you like the store, chances are you’ll love the stock”
We don’t need any hotshot tech companies which we really don’t understand, just by paying attention to the companies we use every day we can discover good investment opportunities.
He gives many examples of companies that he discovered in his day to day life. An example is Taco Bell.
He invested in Taco Bell because he really liked its tacos, and he saw that the shops were always crowded. When he analysed the company he confirmed that its financial condition was good, and its balance sheet was strong.
Taco Bell also had many opportunities to expand throughout the United States.
He purchased Taco Bell at $7 after the price had fallen from $14. It again fell all the way to $1. A fall of 85%. Seeing fundamentals of the company intact, he bought more at $1.
Then the stock began a multi year run and Pepsico acquired it for $42 per share.
Let’s look at your day. You wake up in the morning from your bed (Sleepwell), brush your teeth (Colgate) and then go to drink your tea (Tata Tea) or coffee (Nescafe). Then while bathing you use soap (Lifebuoy). Do this exercise throughout your day. You will definitely find more than 10 listed companies whose products you come across in your life on a day to day basis.
Your Advantage Over Fund Managers
Fund managers have many restrictions about which stocks they can buy, but you don’t. If a fund manager believes that a particular stock will do very well in the future and he wants to make that stock a big part of his portfolio, but he can’t because there is an upper limit on how much percentage any one stock can have in the fund’s portfolio.
Peter Lynch highlights that below sentences is common knowledge among Wall Street analysts:
“You’ll never get fired for buying IBM”
In the fund management business, it goes like, it is okay to go wrong by following the crowd than being right alone. One thing to understand is that fund managers are not only looking for good returns, but also have to keep their jobs.
The investor does not have to choose well-known companies to please his boss. You should search for companies that perform well, even if they are not popular.
Debt-Free Can’t Be Bankrupt
Companies having no debt won’t go bankrupt. This means your downside is protected. Remember Warren Buffett’s 2 rules of investing?
Highly levered companies might create huge wealth during bullish phases or sectoral booms. But when the tide turns, and raising money is scarce, these are the one which will come crashing down hard and destroy all wealth created during the bullish phase.
The PEG Ratio
A new term was coined by Peter Lynch in One Up On Wall Street: PEG of Price Earnings Growth ratio. What you do is divide the P/E ratio of a company by the growth of the company. It is ideal if the PEG ratio is less than 1 according to Lynch.
Size Of A Product As Compared To Total Sales
You might say, “I love Brooke Bond tea. Hindustan Unilever will be a great investment.”
The problem with this kind of thinking is that you must know how much percent does that particular product contribute to the overall sales of the company. Suppose Brooke Bond contributes just 1% to HUL’s sales, and the rest 99% of the products aren’t that great, will HUL still be a good investment for you?
That is why you must look at how much a particular product contributes to the company’s total sales, and not just base your decisions just on the product which you like.
The types of companies
For the author there are six types of companies. Let’s look at its main characteristics:
- Slow growers: established firms with little growth. They tend to stand out for offering high dividends. Peter Lynch does not recommend including them in the portfolio because of the poor performance they offer
- Stalwarts: large and well-established companies. The key is to buy them at a good price, and get a 30-50% return in a couple of years. The author recommends having these companies in our portfolio as protection against economic recessions
- Fast growers: small, usually new, fast-growing companies, often at 25% annually. This is where we can find our tenbaggers
- Cyclicals: companies that alternate periods of growth with stagnation, due to the economic cycles of their sector. This causes the stock price to go up and down. They are airlines, cars, mining, etc.
It’s important to buy them at the good part of the cycle, and sell them just before it’s over (which isn’t easy)
- Turnarounds: These are companies that are going through difficulties. They have bad results, and may even be about to go bankrupt, which makes their price be very low. If the company recovers, the profits are very large.
We must research these companies deeply since some may go bankrupt, thus losing our investment
- Asset plays: This category includes companies that have something valuable that few people know. It can be a new product about to be launched, inventory not valued correctly, or changes in company structure.
Again you have to be careful with this category. We must be very confident that we know the real value of the hidden asset, and its impact on the company’s accounts
Peter Lynch says his favorite category is fast-growing companies, which typically make up 30-50% of his portfolio. He also always has stalwarts and cyclical companies.
A small part of his portfolio is invested in turnarounds and asset play companies.
One Up On Wall Street is one of the best books to get started about investing. It is also a book which I have reread multiple times.